Temporary Components of Stock Returns: What Do the Data Tell Us?

Abstract

Within the past few years, several papers have suggested that returns on large equity portfolios may contain a significant predictable component at horizons of 3 to 6 years. Subsequently, the tests used in these analyses have been criticized (appropriately) for having widely misunderstood size and power - rendering the conclusions inappropriate. This criticism however has not focused on the data - it addressed the properties of the tests. In this paper we adopt a subjectivist analysis - treating the data as fixed - to ascertain whether the data have anything to say about the permanent/temporary decomposition. The data speak clearly and they tell us that for all intents and purposes, stock prices follow a random walk.

JEL Classification: G12